Monday, February 2, 2009

Quantifying the triggers of subprime mortgage defaults

The recent financial turmoil was initially triggered by the rise in defaults by subprime mortgage borrowers, followed by the implosion of the market for securitised assets backed by such loans. Many proposals for setting the economy back on track try to address this root cause, yet the task of designing an appropriate policy response is limited by an incomplete understanding of the drivers behind mortgage default. What measures would most effectively avert future waves of default and increase market transparency without impeding borrowers’ access to loans? Would the remedy involve modifying existing loan terms or instead targeting market failures at an institutional level? This column aims to put the policy debate into perspective by drawing on our empirical analysis of subprime borrowers’ default decisions.